LeapFrog 2005 Annual Report Download - page 137

Equity Incentive Awards. We grant a combination of equity awards to our executives and other key
employees, including performance-based stock awards, time-vested restricted stock and restricted stock unit
awards (or “RSUs”) and time-vested stock options. We believe (1) granting performance-based stock directly ties
LeapFrog’s Section 16 officers to achieving pre-established short- and long-term business goals and (2) time-
vested stock options, restricted stock and RSUs should be part of a balanced equity package to continue to align
our Section 16 officers’ interests with those of the stockholders. When our 2002 Equity Incentive Plan was
amended and approved by our stockholders in 2004 to allow for the granting of full-value stock awards, such as
time-vested restricted stock awards, we initially granted time-vested restricted stock awards to certain of our
Section 16 officers, but have since moved to granting time-vested RSUs to our Section 16 officers and other
employees because RSUs are easier to administer.
The Compensation Committee believes that providing sufficient equity-based incentives for executives
ensures they are motivated over the long-term to respond to the company’s business challenges and opportunities
as owners and not just as employees.
Stock Options. Option grants made to executives from the 2002 Equity Incentive Plan typically have a
four-year vesting period and are made at 100% of the fair market value at close of the market on the business day
immediately preceding the date of grant. Executives receive value from these grants only if LeapFrog’s Class A
common stock appreciates over the long-term. In 2005, the Compensation Committee approved a process
whereby employees, including executives, are generally eligible for “new hire” grants upon initial hire, and then
annually thereafter based on individual performance. The size of option grants is determined by the
Compensation Committee and is based on median competitive practices at companies with which LeapFrog
competes for talent, the employee’s anticipated future contribution and ability to impact LeapFrog’s results, past
performance and alignment among the employee’s peers. At the discretion of the Compensation Committee,
Section 16 officers may also be granted stock options to provide greater incentives to continue their employment
with LeapFrog and to strive to increase the value of LeapFrog’s Class A common stock. Accordingly, in 2005 we
granted awards of stock options to our Chief Executive Officer and our President. For 2005, grants of options,
performance shares and RSUs to executives were determined based on approved annual performance-based grant
guidelines.
Performance Shares. Selected executives at the level of vice president and above receive grants of
performance shares in amounts based upon competitive grant practices and the executive’s level, past
performance and expected future contributions. Performance shares are received by participants at the end of
each three year cycle, and are tied to LeapFrog’s performance against pre-established financial measures. The
first performance shares were granted in relation to the three-year cycle covering 2004-2006. Participants must
continue to be employed at LeapFrog through the end of each three year cycle to receive any shares under the
plan. The measures for 2005 and the 2005-2007 plan cycle include net income, revenue, operating cash flow
(adjusted for current accounts receivable) and total stockholder return. The total stockholder return measure
spans the entire three-year performance share cycle, while the other three measures have annual goals determined
and approved by the Compensation Committee no later than March 31 of each calendar year. For the 2006-2008
plan cycle, the Compensation Committee simplified the program by eliminating the three-year total stockholder
return measure as a program component. The Compensation Committee also adjusted the annual financial
measures for 2006 to include operating profit (as opposed to net income), revenue and operating cash flow
(adjusted for current accounts receivable). The actual shares received by participants will vary from zero to 200%
of an executive’s target payout, based upon LeapFrog’s actual performance over the three-year performance
period. Awards earned under the performance share program, if any, will generally be vested and issued as shares
at the end of each three year cycle.
In 2005, LeapFrog did not meet its threshold goals for 2005 on the three annual measures of net income, net
sales and operating cash flow (adjusted for current accounts receivable), and thus the portion of performance
shares attributable to calendar year 2005 was not earned under either the 2004 – 2006 plan cycle or the 2005 –
2007 plan cycle.
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